Probe Turns Up Heat on Banks

Posted on August 13, 2013

Posted by: Jeff Brownlee

By Alan Zibel and Brent Kendall
The Wall Street Journal

The Justice Department is targeting banks that service a broad range of what it considers questionable financial ventures, including online payday lenders.
The government has issued subpoenas to banks and other companies that handle payments for an array of financial offerings, ramping up an investigation that has been under way for several months, according to Justice Department officials and other people familiar with the matter.

It’s a shift in strategy: Rather than just targeting individual firms, the government is now going after the infrastructure that enables companies to withdraw money from people’s bank accounts.

The volume of online payday lending—a term for smaller, short-term loans at high interest rates—grew to $18.6 billion in 2012, up 10% from the previous year, accounting for nearly 40% of industrywide payday-loan volume, according to investment bank Stephens Inc.

Regulators are also trying tamp down phone and online offers in which marketers try to get people to pay for services that they don’t intend to deliver. These can include offerings to erase debt or offerings of work-from-home programs that don’t lead to jobs, officials say.

“We are changing the structures within the financial system that allow all kinds of fraudulent merchants to operate,” a Justice Department official said, with the intent of “choking them off from the very air they need to survive.”

The move is sparking complaints among online lenders who say the government is attempting to kill a legitimate and fast-growing industry that millions of low-income people rely on to cope with financial emergencies.

Government pressure that forces banks to stop processing payments “would cut off an important credit choice for millions of underserved consumers,” said Peter Barden, spokesman for the Online Lenders Alliance. “It should also send a troubling message to banks that at any point regulators can force them to stop processing legal transactions simply because they don’t like a particular merchant or industry.”

Electronic payment systems handled tens of trillions in transactions last year ranging from food stamps to utility bills to payrolls. Third-party payment firms help merchants and lenders process transactions through banks. Several government agencies have publicly expressed concern about suspicious activities, including fraudulent transactions and money laundering. Banks and payment processors generally collect a fee for each transaction.

The industry-run group overseeing electronic transactions, NACHA, says it has made clear that banks are responsible for ensuring the validity of all transactions on the system. “We welcome combined efforts to identify and address the worst abusers” of electronic payments and will cooperate with law enforcement and regulators, a spokeswoman said.

The Federal Deposit Insurance Corp. has begun warning banks to stop processing payments on behalf of online short-term lenders, including those connected to Indian tribes aiming to operate outside state regulation, according to people familiar with the matter. Some online lenders offer short-term loans with annual interest rates of more than 700%.

The Office of the Comptroller of the Currency has told the banks it regulates to review their business relationships with short-term lenders, out of concern that enabling automatic deductions from customers’ accounts could harm a bank’s reputation.

The FDIC is working to make sure banks are “effectively managing relationships with payment processors and higher-risk merchants, such as payday lenders,” said FDIC spokesman Andrew Gray.

Thirty-five states allow payday lending, while 15 others and the District of Columbia effectively ban such loans, mainly through interest-rate caps. But numerous Indian tribes have begun making loans over the Internet and argue they are sovereign states not subject to state-level regulation. Other lenders assert they don’t have to comply with state laws if they set up shop offshore or in states with favorable regulations such as Delaware and Utah.

Earlier this week, Benjamin Lawsky, superintendent of the New York Department of Financial Services, sent 35 online and tribal lenders cease-and-desist orders telling them to stop offering “illegal payday loans that trap families in destructive cycles of debt.” He also urged more than 100 banks to “choke off” access to payday loans.

Officials said banks have begun voluntarily self-disclosing wrongdoing to the Justice Department and cutting off access to payment processors they consider questionable. Several banks that had been working on payment-processing deals with Indian tribes have since backed out, according to a person familiar with the matter.

Justice Department officials said they are examining payment processors and banks of various sizes and are working closely with the Federal Trade Commission, which has been targeting alleged scammers and online lenders that engage in deception.

Banks say they are taking steps to curb abuses. J.P. Morgan Chase & Co reports unauthorized electronic transactions to NACHA, a spokeswoman said, and the bank earlier this year decided to charge one fee a month instead of multiple charges if a company such as a payday lender makes repeated attempts to deduct funds from a customer’s account with insufficient funds.

The bank is circulating a proposed rule change for the electronic-payments network that would fine banks with an excessive number of returned payments. A high volume of returned payments can be a sign that a company is engaged in fraudulent activity or other illicit behavior, payment-industry experts say.

The Justice Department’s move is an outgrowth of a financial-fraud task force established by President Barack Obama in the wake of the 2008 financial crisis.

In a preview of the type of case the government may bring, the Justice Department last November filed civil charges against First Bank of Delaware, alleging it knowingly processed fraudulent financial transactions. The bank, which dissolved last year after being stripped of its state charter, agreed to settle the case, denying liability and paying a $15 million penalty and another $500,000 in restitution for consumers.

A key focus, officials said, is whether the banks or processors violated a 1989 law—passed in the wake of the U.S. savings-and-loan crisis—that allows the U.S. to recover civil penalties for fraud and other violations.